Tuesday, July 31, 2012

One can see many ways in which prices are set in the real world, from volatile prices on speculative, secondary financial asset markets and primary commodity markets, to auction markets, and to the haggling that can occur in bazaars and street markets, especially for second hand goods.

But a fundamental empirical observation about many markets for newly produced goods and services, especially in industrial markets, is that prices are administered or set by corporations and businesses, according to normal production costs plus a profit markup.

Some observations on this follow:

(1) often business leave their prices unchanged for significant periods of time, from three months to a year, despite changes in demand (Gu and Lee 2012: 462). When prices are adjusted this is the result of changes in factor input costs, including raw materials and labour. Changes in the profit markup result from competition and need for profit.

(2) The profit markup is itself often stable as well, which leads to some degree of stability of profits that results from price administration (Gu and Lee 2012: 461). Stable profits in turn allow stable margins for internal financing of investment (Melmiès 2012).

(3) the advantages of price setting to businesses include the reduction of the occurrence of price wars, goodwill relationships with customers, and stable selling costs (Gu and Lee 2012: 461).

(4) empirical studies show that, outside given limits, businesses find that variations in their set prices produce no significant change in sales volume, and, above all, when prices are cut, this does not necessarily lead to changes in short term market sales (Gu and Lee 2012: 462). And experiments with prices adjusted downwards to a significant extent show that this causes a severe blow to profits, so severe indeed that enterprises quickly abandon all such experiments (Gu and Lee 2012: 461).

Sunday, July 29, 2012

In a talk on April 9, 1975 that Hayek gave to the American Enterprise Institute in Washington DC, he made the following comment on the nature of the business cycle:

“These discrepancies of demand and supply in different industries, discrepancies between the distribution of demand and the allocation of the factors of production, are in the last analysis due to some distortion in the price system that has directed resources to false uses. It can be corrected only by making sure, first, that prices achieve what, somewhat misleadingly, we call an equilibrium structure, and second, that labor is reallocated according to these new prices.

Lacking such price readjustment and resource reallocation, the original unemployment may then spread by means of the mechanism I have discussed before, the “secondary contraction,” as I used to call it. In this way, unemployment may eventually become general.

The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).

But, on reading the Hayek quotation, one is struck by the fact that the central concept is the notion of a tendency to a price vector that will clear all markets (with flexible wages clearing the labour market). This is not an “Austrian” idea at all: it is a Walrasian or neo-Walrasian neoclassical idea, straight from general equilibrium theory. The Austrians did not invent this, but simply borrowed it from Walrasian neoclassicals.

A fundamental theoretical point of Post Keynesian economics – and indeed much heterodox economics in general – is the rejection of the notion of a market tendency to general equilibrium, with extensive arguments why there is no such tendency, owing to the presence of fundamental uncertainty, subjective expectations, the failure of Say’s law, the non-neutrality of money, and the falsity of the gross substitution axiom.

Here we have the most astonishing sight of vulgar internet Austrians complaining that the critics do not understand “basic Austrian” concepts, yet these same Austrians are unaware that the very concepts in question they invoke are nothing but mainstream neoclassical equilibrium fictions, which are held by all orthodox economists such as New Classicals, monetarists and (to some extent) even the New Keynesians.

And, more seriously, certain Austrians such as the radical subjectivists do even accept that idea of market tendency to general equilibrium. Other Austrians such as Rizzo and O’Driscoll have substituted the notion of “pattern coordination” for general equilibrium theory.

If this does not prove how absurd and ignorant is this type of internet Austrian, with their endless carping about “not understanding basic Austrian concepts,” then frankly nothing will.

The use of words “economic calculation” are almost a mantra for vulgar internet advocates of Austrian economics. When criticisms are made of Austrian economic theory, the usual red herring response is some charge of having failed to understand “economic calculation.”

The last time I dealt with this issue it led to the following exchange:

The upshot of all this was Jonathan Finegold Catalán’s view of the Austrian business cycle theory (ABCT) as one theory within the broader Austrian theory of economic coordination and discoordination:

“To clear up any confusion amongst third party readers, what I call the “theory of intertemporal discoordination” is Austrian business cycle theory — I prefer my term, because I think it gets across what the theory is about much better than the conventional one. Furthermore, as I posited in my original post, the new term suggests that the theory is only one facet of many within the body of theory of economic coordination (and discoordination). More accurately, it describes an artificial tendency of discoordination between investment and societal time preference (the latter dictating the aggregate stock of savings at any given point in time).”

The ABCT is one of economic miscalculation and malinvestment. This overarching, broader Austrian theory of economic calculation is supposed to show how the market economy would work free from government distortions.

The fundamental part of this broad Austrian theory of economic coordination/discoordination is the role of prices in a market economy.

Supposedly government deficit spending, price controls, subsidies, income policies, and so on will impair economic calculation on the market by impairing prices, presumably in some disastrous destabilising way.

But it is not difficult to see how the Austrians have a view here that sees the market as ridiculously feeble. For example, does the existence of some minor government subsidies cause an Austrian trade cycle? Would they impair the ability of the private sector to engage in production of commodities with rising real output? Would they distort the market so badly that nobody could engage in “economic calculation”?

For example, the idea that the normal types of government spending cause some severe problems of “economic calculation” leading to market chaos is patent nonsense.

Whatever “distortion” government causes is no more or less severe than what the private sector itself imposes. For example, it is absurd to believe that the millions of agents offering goods and services get their prices right in terms of demand/supply dynamics. Many corporations and business are in fact price setters/administrators: they set their prices according to production costs and then a profit markup, then leave them unchanged for significant periods of time, even when demand changes, as even Ludwig Lachmann understood (Lachmann 1986). The prices are not fundamentally set by supply/demand dynamics at all: they are set by central planners in corporations. A market economy at any one moment has a vast number of “wrong” prices. But this does not mean that the market collapses: it still achieves investment, production and economic growth over long periods.

The alleged price “distortions,” either public or private, don’t destroy capitalist economies. They don’t prevent vast and successful private production of wealth and investment. In the case of price setting, the empirical literature suggests that it has benefits they outweigh costs: stability of profits and the prevention of disastrous price wars between businesses, for example.

And completely “unadulterated” prices in a free market would not necessarily be right prices in the sense imagined by neoclassical or Austrian economics at all. Many would be wrong, merely because producers/sellers aren’t perfect.

But the market system doesn’t require “right” prices in the standard economic sense of equilibrium prices to be successful and dynamic.

If we extend this analysis from price setting to profits, we can say that the existence of significant price setting in many markets by private businesses does not mean the economy is necessarily subject to some unsustainable and devastating “economic calculation” problems, because profits are, thereby, also made stable.

A consequence of price setting is a kind of profit “setting”: profits for the firm are made stable by price setting activities. Far from being a cause of intractable “economic calculation” problems, this profit stability is more likely a strong stabilising factor for modern businesses: for stable profits allow stable margins for internal financing of investment (Melmiès 2012).

The market system is far more robust than what Austrians think it is, with their feeble-minded obsession with price distortions.

UPDATE

I have added a quick update above on the role of profits in light of Jonathan Finegold Catalán’s reply to this post here:

Menger’s treatment of money developed in the course of his life, and I have always had the impression that his view of the origin of money was not as extreme and dogmatic as later Austrians like Mises and Rothbard.

Even in 1892, Menger made a most curious concession at the beginning of this crucial passage (highlighted in yellow):

“It is not impossible for media of exchange, serving as they do the commonweal in the most emphatic sense of the word, to be instituted also by way of legislation, like other social institutions. But this is neither the only, nor the primary mode in which money has taken its origin. This is much more to be traced in the process depicted above, notwithstanding the nature of that process would be but very incompletely explained if we were to call it ‘organic,’ or denote money as something ‘primordial,’ of ‘primaeval growth,’ and so forth. Putting aside assumptions which are historically unsound, we can only come fully to understand the origin of money by learning to view the establishment of the social procedure, with which we are dealing, as the spontaneous outcome, the unpremeditated resultant, of particular, individual efforts of the members of a society, who have little by little worked their way to a discrimination of the different degrees of saleableness in commodities.” (Menger 1892: 250).

Of course, Menger’s main theory is that precious metals have arisen as a medium of exchange among many peoples because “their saleableness is far and away superior to that of all other commodities” (Menger 1892: 252). Yet he also recognised the “important functions of state administration” in creating coinage and creating public confidence in the “genuineness, weight, and fineness” of coined money (Menger 1892: 255). Another important point is that Menger held that the government reduces the uncertainty associated with “several commodities serving as currency” by official legal recognition of some commodities as money, or where more than one commodity money exists by fixing a definite exchange ratio between them (Menger 1892: 255). In this way, governments have perfected precious metals in their function as money (Menger 1892: 255).

It is curious that the 2nd edition of Menger’s Grundsätze der Volkswirtschaftslehre (Vienna, 1923) has apparently never been translated into English, so his final thoughts on the nature of money require a reading of that book in the original German.

In 1892, Menger published an article on money (or “Geld” in German) for the Handwörterbuch der Staatswissenschaften, and this was revised in 1900 and 1909.

By the time of the 1909 article on money, Menger had expanded and rewritten his comments and had added a section called “The Perfecting of the Monetary and Coinage System by the State” (Menger 2002 [1909]: 45–48). In discussing the advantages of a uniform state minted coinage, Menger even remarks that “in recent times, private coinages have met the general requirements of trade only imperfectly” (Menger 2002 [1909]: 46). And while opposing legal tender law as necessary from an economic point of view, nevertheless “in certain cases the needs of trade seem to permit and occasionally downright to require not only some sort of government intervention but specifically the declaring of particular kinds of money as legal tender” (Menger 2002 [1909]: 82). Menger uses decidedly utilitarian ethical reasoning in concluding that legal tender law can be justified (Menger 2002 [1909]: 82–83).

All this suggests that Menger’s thought on money was more subtle and less extreme than that of some modern Austrians.

Richard F. Kahn was lecturer (1933-1951) and Professor of Economics (1951-1989) at Cambridge (UK), and one of the original five members of Keynes’s “Circus.”

Kahn delivered this talk at the time when the UK was experiencing the last years of the economic and social catastrophe of Thatcherism. For the history of the failure of monetarism in Britain and the horrors of Thatcherism generally, I highly recommend Michael Stewart’s Keynes in the 1990s: A Return to Economic Sanity (Harmondsworth, 1993).

Kahn’s voice is a bit faltering at times, but for me this is of great historical and intellectual interest.

The astute reader will know that the title of the talk is taken from a now classic monograph of Nicholas Kaldor called The Scourge of Monetarism (Oxford and New York, 1982), where Kaldor developed endogenous money theory. I think many would argue that Kaldor had a very important role in bringing endogenous money theory to the serious attention of heterodox economists in the English speaking world.

Back in the late 1970s and early 1980s the cult of monetarism was at its height, although the attempts to implement it in the real world by (1) Paul Volcker at the Fed (from 1979 to 1982) and (2) Thatcher in her early years were an unmitigated disaster. It is no secret that Thatcher essentially abandoned her version of monetarism in 1981, under the advice of Alan Walters, which proves, if nothing else, that the lady really was for turning.

Central banks do not directly control the broad money stock or its growth rate. This was the great lesson of those years.

Kahn’s talk here is very much a postmortem on Thatcherite monetarism, though with many other interesting points and observations.

BIBLIOGRAPHY

Kaldor, N. 1982. The Scourge of Monetarism. Oxford University Press, Oxford and New York.

(1)Steve Keen, “The Euro as the SDR of Europe?,” Debtdeflation.com, July 26th, 2012.
A nice analysis form Steve Keen on why the Eurozone is such a disaster. Keen makes the point the point that economists “as widely apart ideologically as Wynne Godley and Milton Friedman observed long before the Euro began that it would fail (a) because it imagined that a market economy would reach a harmonious equilibrium on its own without government intervention—which Godley correctly characterized as a deluded neoclassical fantasy; and (b) because it pushed together widely disparate nations which Friedman noted were utterly unsuited to a currency union.

Wednesday, July 25, 2012

The gem comes from 1.41 to the end of the video, thought one has to watch the whole video to appreciate his remark on the stupidity of the efficient markets hypothesis and the housing bubble. After he makes his final comment, the deadpan silence that follows is the funniest thing I have seen all week.

As a follow up on my post criticising Lynn and Vanhanen’s IQ and the Wealth of Nations (2002), I provide a video interview below with Professor James R. Flynn, an internationally renowned political philosopher and researcher on human intelligence, known for his work on the Flynn effect (the general rise in average IQ scores in many nations over the past 100 years). Flynn is a social democrat and a strong defender of humane political and social ideas, and an academic opponent of racist ideas on human IQ.

Tuesday, July 24, 2012

And here I don’t mean their utopian classless, stateless society (which they called “pure communism”), but the transitional system they advocated in The Communist Manifesto (English trans. 1888 edn., based on the 1872 German edn.; the first German edn. was published in 1848).

Here is what they advocated:

“The proletariat will use its political supremacy to wrest, by degrees, all capital from the bourgeoisie, to centralise all instruments of production in the hands of the State, i.e., of the proletariat organised as the ruling class; and to increase the total productive forces as rapidly as possible.

Of course, in the beginning, this cannot be effected except by means of despotic inroads on the rights of property, and on the conditions of bourgeois production; by means of measures, therefore, which appear economically insufficient and untenable, but which, in the course of the movement, outstrip themselves, necessitate further inroads upon the old social order, and are unavoidable as a means of entirely revolutionising the mode of production.

These measures will of course be different in different countries.

Nevertheless, in most advanced countries, the following will be pretty generally applicable.

1. Abolition of property in land and application of all rents of land to public purposes.
2. A heavy progressive or graduated income tax.3. Abolition of all rights of inheritance.
4. Confiscation of the property of all emigrants and rebels.
5. Centralisation of credit in the hands of the state, by means of a national bank with State capital and an exclusive monopoly.
6. Centralisation of the means of communication and transport in the hands of the State.
7. Extension of factories and instruments of production owned by the State; the bringing into cultivation of waste-lands, and the improvement of the soil generally in accordance with a common plan.
8. Equal liability of all to work. Establishment of industrial armies, especially for agriculture.
9. Combination of agriculture with manufacturing industries; gradual abolition of all the distinction between town and country by a more equable distribution of the populace over the country.
10. Free education for all children in public schools. Abolition of children’s factory labour in its present form. Combination of education with industrial production, &c, &c.” (Marx and Engels 1985 [1888]: 104–105).

The essence of the transitional Communist system was the complete nationalisation of all industry and business: the state would itself own all capital goods, and by implication centrally plan production and consumption of commodities, even the media (by point (6)).

But, in addition to this, the state would abolish private property rights in land and housing, and even the right to inherit private property (with the exception of insignificant personal family property), as in points (1) and (3) above. Indeed, according to Marx and Engels, this is essence of the Communist system:

“In this sense, the theory of the Communists may be summed up in the single sentence: Abolition of private property.” (Marx and Engels 1985 [1888]: 96).

Point (5) also requires the abolition of private banks, and state monopoly on banking.

In point (10), we find a strong opposition to child labour, which Marx and Engels were passionately opposed to. They stressed this in The Communist Manifesto in these words:

“Do you charge us with wanting to stop the exploitation of children by their parents? To this crime we plead guilty.” (Marx and Engels 1985 [1888]: 100).

But the disgust at the economic exploitation of children was hardly unique to Marxism: for example, even deeply Christian, 19th century Tory radicals and paternalists in the UK were vehement opponents of child labour, and were a driving force behind legislation to outlaw it.

Point (9) stands as a very strange, anti-urban – and even deluded – idea: to reduce the population of cities and redistribute population to rural areas.

It is obvious how all this requires an authoritarian, even totalitarian, political system, and it is not surprising that Marx and Engels advocated a “dictatorship of the proletariat”: abolition of democracy, freedom of speech, the rule of law and legal and civil rights. For these reasons alone – even before we get to economic objections – Marxism stands as just another decidedly evil and monstrous authoritarian doctrine.

It can be seen how radically different the Marxist transitional state is from a modern economy with Keynesian macroeconomic management:

(1) The Marxist transitional state requires complete nationalisation of all production; by contrast, a Keynesian system is one where the vast majority of all production is done privately.

(2) Private property rights are extensive and a fundamental part of the legal and social organisation of states with a Keynesian heritage. In the Communist system, even private ownership of land, housing and the right to inheritance are abolished.

(3) In many modern states, even when central banks exist, banking is largely conducted by private financial institutions. The Marxist transitional state would have all banks nationalised. A further observation is that Marxism would essentially abolish developed markets for financial assets, especially secondary financial asset markets.

(4) Communication media tend to be largely privatised in modern states with a history of Keynesian macroeconomic management. Even in states with one nationalised television or media network (e.g., the UK with the BBC), all other media are privatised. In the Marxist state, all media are controlled by the state.

(5) Keynesianism requires no bizarre commitment to shifting population to rural areas.

(6) Keynesianism requires no “equal liability of all to work,” even though I dare say there are many people, even in Western countries, who might feel intuitively that this idea has some appeal.

At most, modern states do resemble the transitional Marxist state in point (2) (the progressive income tax) and point (10) (free or subsidized public education for children and abolition of child labour). But there are so many other differences (and significant ones to boot) that anyone who asserts, for example, that the modern UK or Canada must be communist because they have public education and no child labour is just guilty of stupid and lazy reasoning: committing the fallacy of hasty generalization and possibly the fallacy of composition.

Above all, what distinguishes capitalism ameliorated by Keynesianism historically from Communism is the commitment to democracy, freedom of speech, freedom of religion, the rule of law and civil liberties. Although one can certainly find authoritarian states that practised Keynesianism in the past (e.g., fascist Japan and modern China), I say “historically” because the broad sweep of nations where Keynesianism has existed over the past 70 years have been overwhelmingly democratic and in the liberal tradition. To illustrate what I mean here, note how Chicago school monetarism was practised by Augusto Pinochet’s Chile (a dictatorship), but it is a bad mistake to think that monetarism is inherently authoritarian or requires authoritarianism. Most nations that have implemented monetarist ideas have been democratic: monetarism as a macroeconomic theory and practice is essentially neutral with respect to the political organisation of the nation where it is implemented. The same can be said of Keynesian economics, which in fact presupposes a very significant amount of private enterprise and private production.

One of the more interesting verdicts of Keynes on Marxism was that the doctrine was a “sickness of the soul” (Skidelsky 1992: 517), and, while Keynes was in a conversation with T. S. Eliot in 1934, Virginia Woolf described Keynes as he commented on Marxism:

“[sc. Keynes adressed] The economic question: the religion of Communism. [sc. Marxism was the] ... worst of all and founded on a silly mistake of old Mr. Ricardo’s which M[aynard] given time will put right.” (from the diary of Virginia Woolf, quoted in Skidelsky 1992: 517).

The “silly mistake of old Mr. Ricardo” was nothing less than the labor theory of value, an important point.

The judgement of Keynes on the Soviet Union is given by Skidelsky:

“unlike the Webbs, he [sc. Keynes] could never think of Soviet Russia as a serious intellectual resource for Western civilisation. In the 1920s he had said that Marxism and communism had nothing of scientific interest to offer the modern mind. The depression did not alter his view. Russia ‘exhibits the worst example which the world, perhaps, has ever seen of administrative incompetence and of the sacrifice of almost everything that makes life worth living ...’; it was a ‘fearful example of the evils of insane and unnecessary haste’; ‘Let Stalin be a terrifying example to all who seek to make experiments.’” (Skidelsky 1992: 488).

The opposition of Keynes to Marxism was both economic and political. In reply to George Bernard Shaw in 1935 on the issue of Marx, this is what Keynes said about Marxism:

“Thank you for your letter. I will try to take your words to heart. There must be something in what you say, because there generally is. But I’ve made another shot at old K.[arl] M.[arx] last week, reading the Marx-Engels correspondence just published, without making much progress. I prefer Engels of the two. I can see that they invented a certain method of carrying on and a vile manner of writing, both of which their successors have maintained with fidelity. But if you tell me that they discovered a clue to the economic riddle, still I am beaten – I can discover nothing but out-of-date controversialising.

To understand my state of mind, however, you have to know that I believe myself to be writing a book [viz., The General Theory] on economic theory which will largely revolutionalise – not, I suppose, at once but in the course of the next ten years – the way the world thinks about economic problems. When my new theory has been duly assimilated and mixed with politics and feelings and passions, I can’t predict what the final upshot will be in its effect on action and affairs. But there will be a great change, and, in particular, the Ricardian foundations of Marxism will be knocked away.

I can’t expect you, or anyone else, to believe this at the present stage. But for myself I don’t merely hope what I say, – in my own mind I’m quite sure.”
(Keynes to Shaw, 1 January, 1935, quoted in Skidelsky 1992: 520–521).

And Keynes, as a progressive liberal, was adamant that civil rights and democracy were the most important things that any Western nation needed to preserve:

“... [sc. Keynes] could both love the communist generation for their idealism, and despise them for their muddle-headedness. If Keynes could not solve the ‘primal question’ of how to live, he felt he could solve the secondary question of what to do. His assault on the scientific pretentions of Marxism and the horrors of the Soviet system was unremitting, and needed no revelation of mass murder. He insisted on the supreme importance of ‘preserving as a matter of principle every jot and tittle of the civil and political liberties which former generations painfully secured.’” (Skidelsky 1992: 518).

The conclusions of this book have always seemed bizarre and ridiculous to me.

If you can’t be bothered wading through the work, you can read a summary of its content here and here, or a good critical scholarly review like Richardson (2004).

The blogosphere has recently seen some revival of interest in this book, and, interestingly, of a welcome critical kind. Of all places, the American Conservative has an article questioning the central thesis (not a venue I’d expect to be critical!).

For me the recent criticism is rather old news: for years, I have thought there was something deeply rotten in Lynn and Vanhanen’s IQ and the Wealth of Nations. I’ll review the central thesis of the book and why it is false below.

I. What is Lynn and Vanhanen’s Thesis?
One finding of Lynn and Vanhanen that national differences in per capita GDP are correlated with differences in the average intelligence quotient (IQ) scores is both unsurprising and obviously true (Richardson 2004: 359). The further assertion that the difference in average national IQ is one major factor causing the national differences in GDP and economic growth might seem plausible, at a first glance, but even here doubts arise, if one assumes, as Lynn and Vanhanen do, that the direction from causality runs simply from IQ to GDP.

By the time we get to the book’s conclusion we find highly dubious, even repulsive, ideas indeed:

“The genetic factor in national IQs strengthens our thesis that national IQs are a causal factor responsible for the differences in economic development. The racial differences in intelligence that underlie the national differences in economic development and in the wealth and poverty of nations must have been present for thousands of years. .... If differences in national IQs are genetically determined to a significant extent, as we believe, we have to conclude that it would not be possible to eradicate these differences by any environmental interventions or manipulations except possibly by massive eugenics measures that would not be practical. For this reason, it will be impossible to achieve economic equality between nations. It is more probable that, with further technological developments demanding high intelligence, international economic inequalities will increase even more in the future. Perhaps ultimately, with continued immigration of third world peoples into economically developed nations, there may be such a large amount of biological mixing of racial groups that national differences in intelligence may be reduced and or may even lead to the disappearance of the present differences in national IQs, but such a process would take a long time. Thus, our conclusion is that we must accept that the world is divided into rich and poor countries and that the gap between them is partly based on genetic differences in intelligence, which will make it impossible to equalize economic conditions in different parts of the world.” (Lynn and Vanhanen 2002: 194).

These are words that you have to read again after a first reading, because you doubt if you read them right.

Strangely, after one reads this, on the very next page, one finds Lynn and Vanhanen asserting that “approximately 50 to 60 percent of the variation in per capita income and economic growth rates seems to be due to those other factors, which may include systematic, local and random factors” (Lynn and Vanhanen 2002: 195) – which seems to contradict their previous strident statement. Lynn and Vanhanen (2002: 195) find that the other factor driving economic growth is the extent to which a nation has a market economy, though I frankly doubt whether their simplistic notion of a “market economy” takes account of the extraordinary degree of intervention in, say, newly industrialised nations like South Korea, Japan, and Taiwan, where industrial policy, protectionism and partial government planning of economic development was the key to success.

Lynn and Vanhanen still conclude that “there will inevitably be a continuation of economic inequalities between nations. Intelligence differences between nations will be impossible to eradicate because they have a genetic basis and have evolved over the course of tens of thousands years” (Lynn and Vanhanen 2002: 195).

But, curiously, Lynn and Vanhanen do not draw radical libertarian conclusions from their thesis, but instead argue that the “rich countries may have to accept that they have an ethical obligation to provide financial assistance to the people of the poor countries for the indefinite future” and that “aid programs for the poor countries should be continued” (Lynn and Vanhanen 2002: 196).

Let us move to a critique of Lynn and Vanhanen.

II. Critiques
First, there is the issue of how reliable and representative Lynn and Vanhanen’s test data for many developing nations was: this has always been a legitimate charge levelled at them by critics. Of the 185 nations in their study, direct evidence for national IQ was available only for 81, while for 101 nations average IQ was merely estimated by data from other “most appropriate countries” (Richardson 2004: 359). And even some of the data here seems highly selective and unrepresentative: a survey of just 50 13–16 year olds in Columbia and 48 10–14 year olds in Equatorial Guinea (Richardson 2004: 359). Do samples of less than 50 children really give us reliable data on average IQ in these nations? I doubt it.

To my mind, one of most bizarre and questionable findings of the book was that Qatar (a country with a high GDP and per capita GDP) only had an average IQ of 78. On what was this based? According to Lynn and Vanhanen (2002: 217) it was based on nothing but one study of 273 12 year olds from 1987!

Even putting aside concerns about the reliability of average IQs as reported in the book, the second point fatal to the thesis is the so-called Flynn effect (Richardson 2004: 359).

One can’t really discuss this subject without looking at the work of James R. Flynn (Flynn 2009; Flynn 2008).

In essence, the Flynn effect is the rise in average intelligence quotient (IQ) scores, which are supposed to measure general intelligence (or g), over the course of the twentieth century:

“the Flynn effect is the name given to a substantial and long-sustained increase in intelligence test scores measured in many parts of the world. When intelligence quotient (IQ) tests are initially standardized using a sample of test-takers, by convention the average of the test results is set to 100 and their standard deviation is set to 15 or 16 IQ points. When IQ tests are revised, they are again standardized using a new sample of test-takers, usually born more recently than the first. Again, the average result is set to 100. However, when the new test subjects take the older tests, in almost every case their average scores are significantly above 100.”http://en.wikipedia.org/wiki/Flynn_effect

A consequence of the Flynn effect is that earlier generations would have done poorly on modern IQ tests: average modern IQ is higher than in the past.

If IQ tests really measure innate intelligence, as Lynn and Vanhanen maintain, then we should not see the Flynn effect. If IQ tests do not measure innate intelligence, then the whole study of Lynn and Vanhanen was a waste of time, for the IQ data they accumulate does not reflect the underlying and allegedly innate intelligence of the national populations in question (Richardson 2004: 359). Flynn himself now believes that the Flynn effect is evidence of increased mental ability: if that is so, then the edifice of Lynn and Vanhanen – the supposed largely inflexible nature of IQ – falls like a house of cards.

The rise in average IQ in various countries over time has not been uniform, however.

Richardson has made a more significant criticism of Lynn and Vanhanen’s method:

“Their scheme is to take the British Ravens IQ in 1979 as 100, and simply add or subtract 2 or 3 to the scores from other countries for each decade that the relevant date of test departs from that year. The assumptions of size, linearity and universal applicability of this correction across all countries are, of course, hugely questionable if not breathtaking. Flynn’s original results were from only 14 (recently extended to twenty) industrialised nations, and even those gains varied substantially with test and country and were not linear. For example, recent studies report increases of eight points per decade among Danes; six points per decade in Spain; and 26 points over 14 years in Kenya (confirming the expectation that newly developing countries would show more rapid gains). (Richardson 2004: 359).

Different countries have seen different rates of increase in average IQ, and the most significant rises have been in developing or newly industrialising nations, such as, for example, Japan:

“Lynn and Hampson (1986) review five studies providing evidence on the secular trend of intelligence in Japan for the post World War II period. They conclude that two studies of the early post World War II period show substantial IQ gains of 9.9 and 11.4 IQ points per decade, giving an average of 10.7 IQ points per decade. Three studies of a longer period from approximately 1950–1975 – so for those approximately born 1940–1965 – show lower gains of 9.1, 8.3, and 5.7 IQ points per decade, giving an average gain of 7.7 IQ points per decade. This is the highest gain on a broad intelligence battery in the literature.” (Nijenhuis et al. 2012)

Japan, then, has seen an extraordinary rise in average IQ over this century. In the late 1800s or early 1900s, when Japan began to industrialise and experience industrial take off, it must have had an average IQ as low as any poor developing nation today, even if there was a mild to moderate Flynn effect from the 1860s–1920s. How, then, did Japan achieve such tremendous economic success? (my answer is: a major reason was successful industrial policy). A low average IQ by modern standards did not prevent Japan’s industrialisation, nor should we expect such low IQs to stop economic development in the case of modern developing nations, given the right policies.

Similar things can be said about America: it is likely that the average IQ in America from 1910–1920 was about 76, and was perhaps even slightly lower in the 19th century: and without doubt lower than the average IQ today in Ghana, Congo, Uganda, and Tanzania: yet America still industrialised and developed rapidly. If an average IQ of 76 prevents industrialisation and economic growth, why did America develop?

It is obvious that economic development and GDP growth have complex and multiple causes.

As for IQ, it must be seen as a function of both genetic and environmental factors. So what are the environmental factors that influence IQ? Most probably disease control, health care, nutrition, diet, culture and education. And these obviously have a very significant influence.

In the last few years, there has emerged strong evidence that simple interventions to reduce and prevent infectious disease in children will increase IQ considerably:

“Infectious disease is a factor that may rob large amounts of energy away from a developing brain. ... A great deal of research has shown that average IQ varies around the world, both across nations and within them. The cause of this variation has been of great interest to scientists for many years. .... Before our work, several scientists had offered explanations for the global pattern of IQ. Nigel Barber argued that variation in IQ is due primarily to differences in education. Donald Templer and Hiroko Arikawa argued that colder climates are difficult to live in, such that evolution favors higher IQ in those areas. Satoshi Kanazawa suggested that evolution favors higher IQ in areas that are farther from the evolutionary origin of humans: sub-Saharan Africa. .... We tested all these ideas. In our 2010 study, we not only found a very strong relationship between levels of infectious disease and IQ, but controlling for the effects of education, national wealth, temperature, and distance from sub-Saharan Africa, infectious disease emerged as the best predictor of the bunch. A recent study by Christopher Hassall and Thomas Sherratt repeated our analysis using more sophisticated statistical methods, and concluded that infectious disease may be the only really important predictor of average national IQ.”

All of this totally undermines the idea of Lynn and Vanhanen that IQ differences between nations will be impossible to eradicate because of some kind of rigid and inflexible genetic cause of IQ.

III. Conclusions
The recent finding that the Flynn effect appears to have ended in some developed nations means that over time, with improved epidemiology, post and prenatal care, nutrition, education, welfare and economic development, national differences in average IQ scores will significantly diminish to insignificant levels.

One might conclude that the average national IQ is simply a measure of the size of a country’s educated middle class, and the size of that middle class is a consequence of industrial development (Richardson 2004: 359), and other factors.

Whatever the genetic component in human intelligence, it is clear that intelligence, if IQ tests really measure it, is also a function of environmental factors like epidemiology, health care (including pre-natal and natal and childhood health care), nutrition, diet, culture and education.

We can expect the IQ gap between the developing nations and the developed nations to close in the course of this century, as the Flynn effect most probably hits a wall in the developed world and the third world catches up. That will require a wide range of good policies to address all the factors that effect IQ.

Book Reviews of IQ and the Wealth of Nations
Godina, Elena. 2005. “IQ and the Wealth of Nations. By Richard Lynn & Tatu Vanhanen,” Journal of Biosocial Science 37.6: 783–785.

(1) Keynesians do not ignore uncertainty, and the heterodox Keynesians, above all, have developed Keynes’s ideas on uncertainty to a very great extent (e.g., G. L. S. Shackle and Paul Davidson).

(2) The implied Austrian belief that having the government “do nothing” would decrease uncertainty, and restore business confidence, is both ridiculous and risible. A “do nothing” policy in 2008 would have collapsed the financial system, caused millions to lose their savings, induced a depression, and shocked business expectations to an extent far greater than any “regime uncertainty” caused by the Obama administration.

(3) Whatever uncertainty is caused by the factors Kurdas lists (Obamacare, regulatory explosion, giant budget deficits, anti-business rhetoric and threats of increasing taxes) – and no doubt to some business people these things are a matter of concern – would be overcome by sufficient aggregate demand and a surge in demand for the products of business.

Paul Davidson has recently addressed this very issue:

“Recently I went to a well-known restaurant in Evanston, Illinois. ... But the night I was there, it was less than half full. I asked the manager if he would he hire more waiters and chefs if his taxes were reduced and/or government removed the existing regulations controlling the way his restaurant could operate. His answer was that even if his taxes were reduced and regulations eliminated, he would only hire more staff if more customers came in for dinner. On the other hand, if there were twice as many customers for dinners than there were on this night (and there were many more customers before the recession began in 2007) he would gladly double the number of workers he employed even if his taxes were not reduced or regulations changed.

That’s how things work in the Real World. This simple case illustrates clearly that entrepreneurs will have confidence to expand and hire more workers only if they find the market demand for their products and services strong and growing.”

Saturday, July 21, 2012

Paul Davidson gives a talk here on mercantilism from the perspective of the international payments system. There are also good, but brief, comments on the opposition of Keynes (1933) to the principle of comparative advantage (from 28.22-29.20).

This was part of a panel entitled “Is Mercantilism Doomed to Fail? China, Germany, and Japan and the Exhaustion of Debtor Countries,” held at the Institute for New Economic Thinking (INET) Paradigm Lost Conference in Berlin (April 13, 2012). The second video is the question and answer session.

A great interview below with the American Post Keynesian Paul Davidson, by the INET (Institute for New Economic Thinking) Executive Director Robert Johnson. You can also view the videos here.

Davidson discusses a whole range of topics, but, above all, Post Keynesian theory, uncertainty, and financial markets. Video 2 has a very good discussion of fundamental uncertainty and Davidson’s own contribution to this concept, in terms of ergodic and non-ergodic stochastic systems.

Hudson, M. 2004. “The Development of Money-of-Account in Sumer’s Temples,” in M. Hudson and C. Wunsch (eds.), Creating Economic Order: Record-Keeping, Standardization, and the Development of Accounting in the Ancient Near East, CDL Press, Bethesda, MD. 303–329.

This is an in-depth interview with Steve Keen by Aaron Wissner (a mathematician), conducted in July 2012 while Keen was at the Fields Institute for Research in Mathematical Sciences (University of Toronto, Ontario, Canada).

Monday, July 9, 2012

I was particularly struck by this remark of Hayek which, I understand, he gave in an interview to a Chilean newspaper:

“[A]s long-term institutions, I am totally against dictatorships. But a dictatorship may be a necessary system for a transitional period. At times it is necessary for a country to have, for a time, some form or other of dictatorial power. As you will understand, it is possible for a dictator to govern in a liberal way. And it is also possible for a democracy to govern with a total lack of liberalism. Personally, I prefer a liberal dictator to democratic government lacking in liberalism. My personal impression. . . is that in Chile . . . we will witness a transition from a dictatorial government to a liberal government . . . during this transition it may be necessary to maintain certain dictatorial powers, not as something permanent, but as a temporary arrangement.”

So there we have it: when the chips are down, Hayek presumably preferred dictatorship to a state with the rule of law and a social democratic or democratic socialist economics.

One wonders whether, if in his day when pressed, he would have expressed preference for Pinochet’s Chile (where people where regularly “disappeared”) to social democratic Sweden?

By contrast, a fair point that Hayek makes is that a dictator can pursue “liberal” or laissez faire policies. This is perfectly true: Mussolini originally pursued standard free market, neoclassical policies:

It is perhaps with this in mind that we must view the remark by Mises on Mussolini’s fascism:

“It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history. But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error.”
Mises, 1978 [1927]. Liberalism: A Socio-Economic Exposition (2nd edn; trans. R. Raico), Sheed Andrews and McMeel, Mission, Kansas. p. 51.

All in all, you don’t see the Austrians commenting much on these disgraceful remarks by either Hayek and Mises.

Sunday, July 8, 2012

I was struck in a recent re-reading of Caldwell’s book on Hayek by this passage:

“Hayek’s starting point was a system that was in a state of (what might be called, following Blaug [1990a, 185-86]) total equilibrium. He would then show what sorts of things would have to happen for the system to fail to adjust properly (i.e., fail to return to equilibrium) when it was disturbed. This approach was logically impeccable. However, to insist on starting one’s analysis with a system that is in full equilibrium when that equilibrium implies that all resources are fully utilized seemed bizarre in the midst of the Great Depression” (Caldwell 2004: 163).

Bingo. This is one of the reasons, amongst others, why Hayek’s business cycle theory was judged to be flawed and unconvincing by the economists of his day, and why the Austrians lost out in the 1930s.

I suspect Hayek’s unrealistic assumption of an equilibrium starting point is also the reason why he sounded so ludicrous when he gave a talk at Cambridge around 1931:

“Immediately before giving his early 1931 lectures at LSE, which were his introduction to the school, Hayek gave a one-lecture to the Keynes-dominated Marshall Society at Cambridge. Richard Kahn, one of Keynes’ followers and later his literary executor, described the scene. Hayek had “a large audience of students, and also of leading members of the faculty. (Keynes was in London.) The members of the audience—to a man—were completely bewildered. Usually a Marshall Society talk is followed by a lively and protracted barrage of discussions and questions. On this occasion there was complete silence. I felt I had to break the ice. So I got up and asked, ‘Is it your view that if I went out tomorrow and bought a new overcoat, that would increase unemployment?’ ‘Yes,’ said Hayek. ‘But,’ pointing to his triangles on the board, ‘it would take a very long mathematical argument to explain why’” (Ebenstein 2003: 53).

This anecdote has always seemed strange, but I assume that Hayek here must have been thinking of an economy with full use of resources when he said that extra demand might increase unemployment: an assumption so utterly bizarre in the depths of the Great Depression, it is no wonder if people thought Hayek was crazy.

Monday, July 2, 2012

“For Austrian economists the third quarter of the … [sc. 20th century] was a bad time. To those who lived through them these were years in the wilderness. It is often thought that this eclipse of Austrian fortunes was brought about by the ‘Keynesian revolution’, but in fact this was only one of the misfortunes that befell Austrian economics in the 1930s, a decade of calamity. The promise of an Austrian theory of the trade cycle, which might also serve to explain the severity of the Great Depression, a feature of the early 1930s that provided the background for Hayek’s successful appearance on the London scene, soon proved deceptive. Three giants – Keynes, Knight and Sraffa – turned against the hapless Austrians who, in the middle of that black decade, thus had to do battle on three fronts. Naturally it proved a task beyond their strength.”

Was it some “evil” Keynesian?

The author held that the promise of the Austrian business cycle theory was “deceptive.” Also, that Austrians in the 1930s failed to meet the challenge of Keynes, Sraffa and Frank Knight.

Curiously, it was none other than Ludwig M. Lachmann, in The Market as an Economic Process (Oxford, 1986), p. ix of his preface.

I am in the process of reading this book, and it looks like interesting reading indeed, not just because of Lachmann’s view that there is no tendency to general equilibrium in market systems, but because, by the end of the book, Lachmann appears to be endorsing the Post Keynesian theory of markup pricing (or what he calls “fixprice” [Lachmann 1986: 132]) in certain markets:

“... in our world the flexprice type prevails in financial asset markets and those for raw materials, industrial and agricultural, while in modern industry, except in secondhand markets, the fixprice type predominates.” (Lachmann 1986: 132).

Lachmann is even willing to say that the concept of “market clearing prices” does not really apply to many markets where fixprices are set for other reasons (p. 134), and finds Austrian economics wanting for its failure to study markup prices or fixprices (Lachmann 1986: 130-131).

Further Reading

If you cannot get hold of Lachmann’s The Market as an Economic Process, one can read the following to get an overwiew:

(1) the US, (2) those nations with strong trade surpluses (say, Germany and Japan), (3) those nations that seem to run near perpetual current account deficits but attract a lot of foreign capital (say, Australia), and (4) even the Eurozone, if it were suitably reformed with a union-wide fiscal policy, would be able to achieve full employment via MMT-style policies.

But those nations, especially developing nations, that face real constraints on their current account deficits would perhaps find it difficult to maintain full employment via MMT, if balance of payments crises ensued in response to surging imports.

All this underlines the need for reform of the international payments system. It’s time to give developing countries the support from the IMF and World Bank (suitably reformed) that they need for infrastructure and industrial development to achieve some degree of export balance and internal wealth, to make MMT work.

To be fair, I think Bill Mitchell has tried to address some of these criticisms here:

“… a nation might have a food supply problem just because of location. Then they have to import food. For example, in Kazakhstan where I am working at the moment, they face really significant problems in winter getting fresh vegetables and fruits. Many of these nations also have very little that the World wants by way of their exports. The fact that such a country’s national government is sovereign in its own currency and can spent how ever much it likes in that currency will not solve the problem – there is not enough goods and services (in this case) food for the sovereign government to purchase.

In those situations, a country requires foreign goods and they need to export to get hold of foreign currency or receive development assistance from the rest of the World. In the latter case, I see a fundamental change is required in the role of the IMF (more or less back to what it was intended to do in the beginning). Where are country is facing continual current acccount and currency issues as a result of the need to import essential goods and services, the IMF might usefully act to maintain currency stability for that country. ....

It is often claimed that MMT does not consider exchange rate issues sufficiently. I do not actually know why people think that other than they are just rehearsing their fears that somehow violent exchange rate swings are a common occurrence. They are not. But the story goes that the amorphous financial markets are poised to pounce on any country that runs a budget deficit and will destroy their currency if they feel there is no intention to get back into surplus.

The other angle on this is that deficits apparently fuel import growth and plunge the currrent account into further deficit which then leads to depreciation (if floating) or a foreign reserve drain (if pegged). This, in turn, leads to expectations of further depreciations and the currency is sold short by hedge funds.

They never really say the same thing about a private investment boom which sucks in imported productive capital. Somehow adding productive capacity in the private sector is ‘more efficient or more productive’ than, for example, a large-scale public education policy which increases the capacities of the population in both the workplace but also general life.

They also never really say anything about private imports of luxury cars (so-called positional goods) into developing countries. ....

It is often claimed that MMT does not consider exchange rate issues sufficiently. I do not actually know why people think that other than they are just rehearsing their fears that somehow violent exchange rate swings are a common occurrence. They are not. But the story goes that the amorphous financial markets are poised to pounce on any country that runs a budget deficit and will destroy their currency if they feel there is no intention to get back into surplus.

The other angle on this is that deficits apparently fuel import growth and plunge the currrent account into further deficit which then leads to depreciation (if floating) or a foreign reserve drain (if pegged). This, in turn, leads to expectations of further depreciations and the currency is sold short by hedge funds.

They never really say the same thing about a private investment boom which sucks in imported productive capital. Somehow adding productive capacity in the private sector is ‘more efficient or more productive’ than, for example, a large-scale public education policy which increases the capacities of the population in both the workplace but also general life.”Bill Mitchell, “Current Accounts and Currencies,” Billy Blog, October 25, 2009.

There is serious debate to be had here, not because of any hostility to MMT (indeed I personally regard MMT with sympathy as a more radical form of Post Keynesianism), but in the spirit of constructive criticism.